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Bakery and breakfast cereal manufacturer General Mills recently announced its intention to increase the price of ‘selected’ product lines to reflect the impact of higher commodity costs on production and the broader supply chain.

Rising wheat and corn prices over the last year may prompt similar moves from other bakery manufacturers, particularly those with limited geographical reach beyond the US.

A company heavily dependent on North America

General Mills has a global presence but its profile in emerging markets is rather limited, and, as such, it is strongly focused on developed markets. The company’s chief category is bakery products, which is composed almost entirely of breakfast cereal sales in North America. These account for around 75% of its global retail value sales in packaged food, which reached US$12.2 billion in 2009.

Ending stocks and currency volatility remain a crucial part of the equation

Global wheat prices have risen by 37% over the last year (October 2009-September 2010). Moreover, they have been steadily rising since August 2010 when widespread fires in Russia prompted a self-imposed ban on wheat exports from that country.

The move sent shockwaves through global commodity markets, with traders fearing scarcity of supply and resulting in an immediate escalation in commodity prices. More recently, price rises have been furthered over due to poor prospects for wheat output this year in Canada, which is expected to be 25% lower than in 2009, according to agricultural crop specialists in the country. Current global wheat prices, however, are still around 40% lower than the peak reached in March 2008 when average FOB monthly prices exceeded US$439 per tonne.

Interestingly, movements in wheat prices are as much related to production as to existing stock levels. While production of a specific commodity can be relatively weak at a specific point in time, stocks can always be used by suppliers to satisfy current demand. This means that a relatively poor crop does not automatically translate into a price increase.

According to FAO estimates, wheat stocks in 2011 will stand at a similar level to the previous season – 196 million tonnes (2009/2010) versus 188 million tonnes (2010/2011). Even factoring in a drop in production of around 17 million tonnes (30% of total Russian wheat crops), adjusted stock levels will likely remain only slightly lower than 2008/2009 levels of 178 million tonnes.

Interestingly, the impact of recent wheat price rises has to be assessed in the broader context of US dollar fluctuations. Since August 2010, the US dollar has lost around 10% of its value relative to the euro. A weak dollar means lower real costs for global commodities in EU countries, which therefore suffer less in terms of the impact of dollar-based wheat price fluctuations.

Steady rise in corn prices

Corn prices, which historically tend to be fairly stable, have not escaped the current food commodity inflation trend either. Monthly average prices rose by 23% over the October 2009-September 2010 period, according to FAO official statistics. As with soybeans, corn prices are steadily increasing as a result of strong demand for animal feed in countries like China.

This trend is, according to most industry sources, likely to continue on the back of stronger demand for milk and fresh meat in rapidly growing Asian economies. As seen with wheat, current corn commodity prices remain far lower (by some 28%) than their peak in June 2008.

From the point of view of production, latest US Department of Agriculture (USDA) estimates, released in October, project a 2% increase in global corn output for the 2009/2010 season. Ending stocks are projected to remain stagnant, reaching around 148 million tonnes by the end of this year.

Linking demand of corn to projected sales for a single industry could prove potentially misleading. Although used primarily to feed livestock, corn is a versatile grain with a diversity of uses. It is also processed into a multitude of food and industrial products, including starches, sweeteners, corn oil, beverage and industrial alcohol and fuel ethanol.

Thousands of foods and other everyday items – from toothpaste and cosmetics to adhesives and shoe polish – contain corn derivatives.

Biofuels put pressure on use of land for food production

Research suggests, however, that there will be increased demand for corn for biofuel manufacturing over the short and medium term, driven by demand for renewable energy sources in developed markets. This trend will not only put pressure on global corn commodity prices but will also divert existing land stock from food to fuel production.

One key market expected to see an increase in demand for biofuel is the US. The Energy Independence and Security Act was introduced in 2007 and aims to increase the production of clean renewable fuels.

The act establishes new standards and grants for promoting efficiency in government and public institutions. According to the act, new and renovated federal buildings must reduce fossil fuel use by 55% (from 2003 levels) by 2010, and 80% by 2020.

All new federal buildings must be carbon neutral by 2030. Corn, used for the production of ethanol-based fuels, is therefore a commodity likely to be fully affected by current pressures to increase renewable energy output not only in the US but also across most developed markets.

Stronger demand for cattle feed in China

Animal feed is another key industry set to continue to put upward pressure on corn prices. Total volume sales of meat in China are predicted to grow by 22% over the 2009-2014 period to reach over 100 million tonnes.

In other emerging economies like India and Russia, meat sales are projected to grow by 76% and 34%, respectively, over the same period, according to Euromonitor International’s projections.

Consumer demand for milk, another food staple, will continue to expand steadily in Asian countries where its consumption is not yet widespread.

In China, for instance, total milk volume sales are predicted to grow by 2.3 million litres over 2010-2015, according to Euromonitor International’s projections. In India, this increase will reach over four million litres over the same period.

Future direction

Relatively good prospects for wheat and corn production and ending stocks should mean that a repeat of the price hikes seen in the first half of 2008 remain fairly unlikely.

That said, according to Euromonitor International’s projections, stronger demand from emerging regions and/or relatively poor crop yields in specific countries at particular times could push up wheat prices in real terms (excluding currency fluctuations) by between 3-5% from November 2010 through to the end of 2011. Corn prices, currently under pressure from stronger demand for fresh meat and milk in emerging countries, could see this range increase to 6-8% over the same period, according to Euromonitor International’s projections.

Trading movements linked to worsening prospects for crop yields in any of the key producing markets could, however, push up predicted wheat and corn prices further than presently expected in the short term. If the current weakening of the US dollar continues, the impact of such price rises on food manufacturers heavily reliant on the North American market could be even stronger.

The underlying driver behind overreactions of wheat and corn commodity is, however, not entirely unjustified. There are concerns in the industry about the medium-term capacity of food producers to meet the needs created by future population growth. Between 2009 and 2014 alone, the global population is projected to grow by around 400 million, according to United Nations’ estimates.

Most of this growth will take place in meat, wheat and corn-hungry emerging economies in Asia-Pacific, North Africa and Latin America. By 2050, according to the same UN projections, the world population could reach the nine billion mark, an increase of around 2.5 billion over 2009.

This is the reason why, despite the relative stability of year-ending stocks and crop output, wheat and corn commodities are predicted to remain under pressure over the medium to long term. Crucially, the underlying population growth trend makes them particularly vulnerable to the nervousness currently pervading global food commodity markets.

Large international companies whose activities rely heavily on wheat and corn should try and establish a sustainable sourcing strategy in the medium term.

Manufacturers relying on short-term trading will be highly exposed to price hikes linked to ‘nervous trading’– like the ones seen in wheat immediately after the recent wildfires in Russia. Interestingly, geographical diversification might also help international food manufacturers to offset price increases linked to the volatility of a particular currency.

Overall, research suggests a moderate but sustained increase in wheat and corn commodity prices over the 2011-2015 period. Crucially, those food manufacturers offering high added value bakery and cereal lines will be in a far better position to pass on price increases to consumers. This is because premium consumers show higher elasticity to prices than those in the mass market/mainstream.

In addition, private label bakery manufacturers will be in a relatively good position to internalise some of the commodity-induced price increases through economies of scale linked to mass production.

Those which occupy a space in between the premium and economy price bracket will, however, be the most heavily affected by prospects of food commodity inflation in the medium term – and will accordingly have to adjust their sourcing strategies the most.

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